Bill Gross Explains Why He Is Not Buying Portuguese Debt (Read: Is Short), And Gives His Latest Muni Bond Outlook

While the fact that PIMCO is not a big fan of Europe is not surprising, nor is it surprising that Bill is talking his BAB book, and is therefore bullish on the muni question (especially on a relative basis, in essence saying that the US Treasury is in the same insolvency boat as California), what is surprising is that Newportbeachian, at least superficially, appears honestly confused what happens in June when QE2 ends. Which is funny: Fed's Fisher earlier said that the central bank has reached its limit of asset purchases... barring unexpected shock. Which of course means completely expected to the Fed. And since the Fed has to continue monetizing all the deficit issuance, it has no choice but to continue QE2. The conclusion is that in April or May, something "unexpected" will happen to give the Fed ammo to continue monetizing. May 6 anniversary anyone?

From a Bloomberg TV interview earlier with Margaret Brennan:

Gross on Portugal:

"We do not blame Prime Minister Socrates for touting his market. That's the name of the game in these days, not just in Portugal, but in other countries. They're not like Greece, in other words. And yes, I guess we can give it to him in terms of 80% foreign participation and yes, we can give it to him in terms of a well-bid auction, but basically these auctions are prearranged sales. They are not really auctions. They are bought by domestic banks within euro land and then they're rediscounted to the central bank. So it is internal buying. There are claims of Japan and China and so on, but they're really looking for the private institutions like PIMCO and other insurance companies to buy, and we just have not done that yet."

On Spain and Italy when they come to market:

"They'll come successfully if success is defined by selling bonds. Portugal did sell at 10-year but slightly under 7%. To me that is not a successful yield. It speaks in the long term to Portugal not being able to service its debt simply because its primary deficit is increasing based upon those high yields. Something has to be done. It is being done at least in terms of the talking stage by Merkel and others in terms of extending the blanket that the EU so to speak in terms of EU bonds ahead. It helps to spread the benefit from Germany outward, but I am not optimistic in terms of the peripheral countries, and we would not invest in them at the moment."

On bond vigilantes reaching the US:

"The Fed is buying most of the issuance. They don't do it directly, of course, they do it in different maturities and on separate days in some cases. The Fed will stop buying at the end of June and that becomes the ultimate question as to what will happen at the end of June. Bond yields and bond prices will be dependent upon inflationary expectations, and ultimately on Fed policy, not through quantitative easing but through the length of time they keep the policy rate at 25 basis points. We think that extends for the next two years at least. There's some type of magnet that pulls interest rates down, not just in 5s and 10s, but also in 30s that keeps them from going to 4.5% to 5% at least temporarily.

On at what point the U.S. should get nervous about economic growth:

"Ultimately the size of the deficit, the ultimate amount of debt relative to GDP, which in terms of gross debt in the United States is 90% of GDP, a level that Reinhart and Rogoff suggest slows economic growth ultimately by 1% or so. The deficit, the debt level, the cost of that debt ultimately bears a significant burden on an economy. In the U.S., for instance, if interest rates went up by 50% or double, then the deficit as a percentage of GDP would probably increase by a good half a percent or 1%. Probably in dollar terms by a good $300 to $400 billion. Ultimately the future interest cost will be a problematic focal point for bond investors in and for policymakers."

On his theory of Americans as male praying mantises:

"I used the praying mantis metaphor in my recent investment outlook pointing out that there are consequences for mindless political thrusting and Washington spending policies. We as Americans eventually lose our heads the way a male mantis does in the process of reproduction. Americans' answer to a bulging deficit seems always to be manana. Debt commission recommendations are always dead on arrival, bipartisan compromises result in no tax increases for anyone and an increase in $500 to $800 billion in the fiscal deficit. The point is the current and future generations of American mantises, male or female, will pay for this in terms of a price. They pay for in a number of ways. One in terms of dollar depreciation going forward. And two in terms of lower real wages and lower real interest rates, which are a cost for investors."

On if states should be allowed to bankrupt like municipalities are allowed to do:

"It's very difficult for them to do so and certainly if they can and want to. I do not perceive that as a prospect. Ultimately municipal bankruptcies will be at a lower level. I do not subscribe to the theory that there will be lots of them, but there will be increasing amounts of them. In terms of the states, there are some actions being taken. Illinois raised income taxes from 3 to 5% in a secret session last night. That is progress. Jerry Brown in California is doing something, I suppose, to affect some changes and some balances. States will continue to have problems as long as Congress does not subsidize them, and it does not look optimistic from that standpoint. Spreads will be wide, but I do not see a significant bankruptcy at the state level."

On if Gross would buy munis in California right now:

"I would agree that that is where the pain will be born. That's in California and that is what Jerry Brown is suggesting, shift the burden from the states to the local communities and have them consolidate their operations, police and fire, etc. That makes reasonable sense. In the process there may be some bankruptcies as well. At the local level we should be very observant and aware in terms of potential bankruptcy, but at the state level when you have 300 to 350 basis points spreads on California bonds, ultimately those are attractive relative to the U.S. Treasury, which is in a similar predicament."